Professor Authored Problem Solutions Intermediate Accounting 3. Leases. Solution to Problem 1 Lessor s computation of lease payments

Professor Authored Problem Solutions Intermediate Accounting 3 Leases Solution to Problem 1 Lessor s computation of lease payments In general, the following amounts get input into your calculator: PV! sum of leased assets s fmv and initial direct costs FV total expected residual value at end of lease term N years time compounding periods per year I lessor s rate divided by compounding periods per year PMT? = TYPE end for ordinary annuity, beg for due annuity Case 1 PV!240,600 (235,000 + 5,600) FV 25,000 (25,000 + 0) N 5 I 5 PMT? = 51,048 TYPE end Case 2 PV!52,500 (52,500 + 0) FV 20,000 (12,000 + 8,000) N 8 I 6 PMT? = 6,069 Case 3 PV!171,800 (168,300 + 3,500) FV 15,000 (0 + 15,000) N 8 = 4*2 I 3.5 = 7 2 PMT? = 22,547 295

Case 4 PV!92,000 (90,000 + 2,000) FV 5,000 (0 + 5,000) N 20 = 5*4 I 2 = 8 4 PMT? = 5,421 TYPE end Solution to Problem 2 Compute lease payment PV!605,000 fmv of $600,000 plus lessor IDC of $5,000 FV 50,000 URV of $20,000 plus GRV of $30,000 N 7 lease term, annual compounding I 7 lessor s rate PMT? = 99,516 payments start immediately on date of lease Solution to Problem 3 Compute lease payment. In general, the following amounts get input into your calculator: PV! sum of leased assets s fmv and initial direct costs FV total expected residual value at end of lease term N years time compounding periods per year I lessor s rate divided by compounding periods per year PMT? = TYPE end for ordinary annuity, beg for due annuity PV!483,000 (480,000 + 3,000) FV 23,000 (13,000 + 10,000) N 7 I 8.5 PMT? = 84,631 296

Solution to Problem 4 Operating lease accounting for lessee 1/1/2012 Rent expense 116,196 Cash 116,196 1/1/2013 Rent expense 116,196 Cash 116,196 1/1/2014 Rent expense 116,196 Cash 116,196 1/1/2015 Rent expense 116,196 Cash 116,196 Ppd/ Total Current Long-term Operating Non-op Operating Investing Financing PPE Liability Liability Liability Income Income Activities Activities Activities 2012 0/0 0 0 0!116,196 0!116,196 0 0 2013 0/0 0 0 0!116,196 0!116,196 0 0 2014 0/0 0 0 0!116,196 0!116,196 0 0 297

Solution to Problem 5 Operating lease accounting for lessor. On 1/3/2009, the ABC Company leases a piece of equipment to the XYZ Company for a seven (7) year period (at this date, the equipment has a total expected remaining useful life of fourteen (14) years). The equipment has a fair market value of $900,000 on 1/3/2009, and is carried on ABC's books at a cost and book value of $800,000 (purchased 1/2/2009 with a debit to Leased Assets). ABC expects the equipment to have a residual value of $350,000 when it is returned on 1/3/2016. Only $30,000 of this value is to be guaranteed by XYZ. ABC incurs initial direct costs of $0 in drawing up the lease. ABC expects the equipment to have a residual value of 15,000 at the end of fourteen years, but there is no guarantee of this. ABC structures the annual rental payments of 118,275, due on 1/3/2009 & 1/3/2010 & 1/3/2011 & 1/3/2012 & 1/3/2013 & 1/3/2014 & 1/3/2015, to earn a 7% rate of return (the rate of interest implicit in the lease). XYZ is not aware of ABC s rate. XYZ's cost of capital is 8.2%. This loan is to be accounted for as an operating lease for ABC (LESSOR). Should it be necessary, both ABC and XYZ use straight-line depreciation, with a full year taken in the year of acquisition. Both ABC and XYZ have a fiscal year that extends from January 1 to December 31 of each year. 1. Prepare all necessary journal entries for 2009 and 2010 for ABC (LESSOR) to account for the lease. Assume all payments made as scheduled. No explanations are necessary, but provide dates for all entries. 1/2/09 Leased Assets 800,000 Cash 800,000 1/2/09 Cash 118,275 Rent Revenue 118,275 12/31/09 Depreciation Expense 64,286 Accumulated depreciation 64,286 (800,000-350,000) / 7 1/2/10 Cash 118,275 Rent Revenue 118,275 12/31/10 Depreciation Expense 64,286 Accumulated depreciation 64,286 2-4. What values does ABC (LESSOR) report on its financial statementsfor 12/31/2009 and 12/31/2010? Be sure to identify where on the balance sheet the values are placed. Total Current Long-term Operating Non-op Operating Investing Financing PPE Liability Liability Liability Income Income Activities Activities Activities 2009 735,714 0 0 0 +53,989 0 +118,275!800,000 0 2010 671,428 0 0 0 +53,989 0 +118,275 0 0 298

Solution to Problem 6 Operating lease Part 1: journal entries The annual rent expense for Geddes will be the average annual amount of rent. The average rent is $24,000 (total rent of $120,000 divided by five years). The entry for each year is then: 1/1/2006 Rent expense 24,000 Prepaid rent 6,000 Cash 30,000 1/1/2007 Rent expense 24,000 Prepaid rent 1,000 Cash 25,000 1/1/2008 Rent expense 24,000 Prepaid rent 1,000 Cash 25,000 1/1/2009 Rent expense 24,000 Prepaid rent 4,000 Cash 20,000 1/1/2010 Rent expense 24,000 Prepaid rent 4,000 Cash 20,000 Part 2: financial statement reporting Ppd/ Total Current Long-term Operating Non-op Operating Investing Financing PPE Liability Liability Liability Income Income Activities Activities Activities 2006 6,000/0 0 0 0!24,000 0!30,000 0 0 2007 7,000/0 0 0 0!24,000 0!25,000 0 0 2008 8,000/0 0 0 0!24,000 0!25,000 0 0 2009 4,000/0 0 0 0!24,000 0!20,000 0 0 2010 0/0 0 0 0!24,000 0!20,000 0 0 299

Solution to Problem 7 Operating lease Generally speaking, the annual amount of rent expense is the average amount. However, small increases are permitted from year to year. Consequently, I would take each amount directly to rent expense. 1/1/2006 Rent expense 40,000 Cash 40,000 1/1/2007 Rent expense 45,000 Cash 45,000 1/1/2008 Rent expense 50,000 Cash 50,000 1/1/2009 Rent expense 55,000 Cash 55,000 1/1/2010 Rent expense 60,000 Cash 60,000 Ppd/ Total Current Long-term Operating Non-op Operating Investing Financing PPE Liability Liability Liability Income Income Activities Activities Activities 2006 0/0 0 0 0!40,000 0!40,000 0 0 2007 0/0 0 0 0!45,000 0!45,000 0 0 2008 0/0 0 0 0!50,000 0!50,000 0 0 2009 0/0 0 0 0!55,000 0!55,000 0 0 2010 0/0 0 0 0!60,000 0!60,000 0 0 300

Solution to Problem 8 Lease classification for lessee. The lessee must analyze the terms of the lease to decide whether to treat it as an operating lease or a capital lease. Four criteria must be considered. If one criterion, or more, is met, then the lessee accounts for the lease as a capital lease. If none of the criteria is met, then the lessee accounts for the lease as an operating lease. The four criteria are: (1) Transfer of ownership? If transfer of ownership is one of the lease terms, it should be accounted for as a purchase with financing by the lessor. No. Johnson Company can purchase the equipment at the end of the lease for its market value at that time. If not, the equipment is to be returned to Stark Finance. (2) Bargain purchase option? If the lease terms give the lessee an opportunity to purchase the asset at a price far below what the market value is estimated to be, then proceed with the assumption that the bargain purchase option will be exercised by the lessee No. Purchasing asset for market value is no bargain. (3) Length of lease term $ 75% of asset s total expected life? No. 10/14 is less than 75%.. (4) Present value of minimum lease payments $90% of asset s current FMV? Minimum lease payments (MLP) is technically defined as (1) the periodic cash payments plus (2) any GRV. The rate used in present value computations is the lessee s rate (unless the lessor s rate is lower and known to the lessee, in which case the lessor s rate is used). PV? = 680,577 (98.6% of 690,000) FV 55,000 N 10 I 5.8 (lessor s rate is known and lower, so use it) PMT 82,592 type beg Because one of the criteria is met (#4), and that is all that is needed, the Lessee accounts for this as a capital lease. 301

Solution to Problem 9 Lease accounting for lessee. 1. Prepare an amortization table for XYZ (LESSEE) to aid in the accounting for the lease. Please round all amounts to dollars. Your table should contain an adjustment to account for rounding errors. Solve for PV PV 614,552.00 FV 14,000.00 N Years 6 I (percentage) 6.9 PMT 118,401.00 Annuity (beg/end) beg BOY Bal Date BOY Bal Pmt after pmt Interest EOY Bal Date Jan 1, 2009 614,552 118,401 496,151 34,234 530,385 Dec 31, 2009 Jan 1, 2010 530,385 118,401 411,984 28,427 440,411 Dec 31, 2010 Jan 1, 2011 440,411 118,401 322,010 22,219 344,229 Dec 31, 2011 Jan 1, 2012 344,229 118,401 225,828 15,582 241,410 Dec 31, 2012 Jan 1, 2013 241,410 118,401 123,009 8,488 131,497 Dec 31, 2013 Jan 1, 2014 131,497 118,401 13,096 904 14,000 Dec 31, 2014 2. Prepare all necessary journal entries for 2009 and 2010 for XYZ (LESSEE) to account for the lease. Assume all payments made as scheduled. No explanations are necessary, but provide dates for all entries. 1/1/09 Leased Asset 614,552 Lease Liability 614,552 1/1/09 Lease Liability 118,401 Cash 118,401 12/31/09 Interest Expense 34,234 Lease Liability 34,234 12/31/09 Depreciation Expense 100,092 Accumulated Depreciation 100,092 (614,552! 14,000)/6 1/1/10 Lease Liability 118,401 Cash 118,401 12/31/10 Interest Expense 28,427 Lease Liability 28,427 12/31/10 Depreciation Expense 100,092 Accumulated Depreciation 100,092 302

3. What values does XYZ (LESSEE) report on its balance sheets for 12/31/2009 and 12/31/2010? Be sure to identify where on the balance sheet the values are placed. 4. What values does XYZ (LESSEE) report on its income statements for 2009 and 2010? Be sure to identify where on the income statements the values are placed (including whether or not it is in operating income). 5 What values does XYZ (LESSEE) report on its cash flows statements for 2009 and 2010? Be sure to identify where on the statement of cash flows the values are placed. Total Current Long-term Operating Non-op Operating Investing Financing PPE Liability Liability Liability Income Income Activities Activities Activities 2009 514.460 530,385 118,401 411,984!100,092!34,234 0 0!118,401 2010 414,368 440,411 118,401 322,010!100,092!28,427!34,234 0!84,169 303

Part 1: computation of annual lease payment PV!850,000 (850,00 + 0) FV 50,000 (30,000 + 20,000) N 4 I 5 PMT? = 217,247 Solution to Problem 10 Accounting for lessor and lessee. Part 2: computation of present value of minimum lease payments for lessor PV? =!833,545 FV 30,000 N 4 I 5 PMT 217,247 Part 3: classification of lease for lessor (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? Yes, 4/5 > 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 833,545 850,000 = 98.064% (5) Collectibility of future payments is reasonably predictable? Yes (6) Are the amounts of future unreimbursable costs by the lessor known with reasonable certainty? Yes (7) Does the lessor recognize a profit (fmv > book value) on the leased asset? No, fmv of 850,000 equals recorded cost of 850,000. For the lease to be classified as some sort of capital lease for the lessor, at least one of the first four criteria must be met, as well as both criteria 5 and 6. If not, it is an operating lease. This lease qualifies as some sort of capital lease for the lessor because two of the first four criteria are met, as well as both criteria 5 and 6. Criterion 7 establishes whether it is a direct financing type lease (with no profit) and a sales type lease (with profit). Because there is no profit, this is a direct financing lease to the lessor. 304

Part 4: Lessor s amortization table Lease Rec Cash Lease Rec Interest Lease Rec Date Bal @ BOY Payment after pmt Rev Bal @ BOY Date Jan 1, 2005 850,000 217,247 632,753 31,638 664,391 Dec 31, 2005 Jan 1, 2005 664,391 217,247 447,144 22,357 469,501 Dec 31, 2006 Jan 1, 2005 469,501 217,247 252,254 12,613 264,867 Dec 31, 2007 Jan 1, 2005 264,867 217,247 47,620 2,380 50,000 Dec 31, 2008 Part 5: Lessor s journal entries 1/1/2005 Lease Receivable 850,000 Asset 850,000 1/1/2005 Cash 217,247 Lease Receivable 217,247 12/31/2005 Lease Receivable 31,638 Interest Revenue 31,638 1/1/2006 Cash 217,247 Lease Receivable 217,247 12/31/2006 Lease Receivable 22,357 Interest Revenue 22,357 Part 6: computation of present value of minimum lease payments for lessee PV? =!821,714 FV 30,000 N 4 I 6 PMT 217,247 Part 7: classification of lease for lessee (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? Yes, 4/5 > 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 821,714 850,000 = 96.67% For the lease to be classified as a capital lease for the lessee, at least one of the first four criteria must be met. If not, it is an operating lease. This lease qualifies as a capital lease for the lessee because two of the first four criteria are met 305

Part 8: Lessee amortization table. Lease Pay Cash Lease Pay Interest Lease Pay Date Bal @ BOY Payment after pmt Exp Bal @ EOY Date Jan 1, 2005 821,714 217,247 604,467 36,268 640,735 Dec 31, 2005 Jan 1, 2006 640,735 217,247 423,488 25,409 448,897 Dec 31, 2006 Jan 1, 2007 448,897 217,247 231,650 13,899 245,549 Dec 31, 2007 Jan 1, 2008 245,549 217,247 28,302 1,698 30,000 Dec 31, 2008 Part 9: Lessee s journal entries 1/1/2005 Leased Asset 821,714 Lease Payable 821,714 1/1/2005 Lease Payable 217,247 Cash 217,247 12/31/2005 Interest Expense 36,268 Lease Payable 36,268 12/31/2005 Depreciation Expense 197,929 Accumulated Depreciation 197,929 1/1/2006 Lease Payable 217,247 Cash 217,247 12/31/2006 Interest Expense 25,409 Lease Payable 25,409 12/31/2006 Depreciation Expense 197,929 Accumulated Depreciation 197,929 Part 10: Lessee s reporting on its financial statements for 2005 Date PPE CL LtLiab Op Inc Non-op Inc OA IA FA Dec 31, 2005 623,785 217,247 423,488 (197,929) (36,268) 0 0 (217,247) Dec 31, 2006 425,856 217,247 231,650 (197,929) (25,409) (36,268) 0 (180,979) Dec 31, 2007 227,927 245,549 0 (197,929) (13,899) (25,409) 0 (191,838) 306

Solution to Problem 11 Accounting for lessor and lessee 1. Identify the type of lease (i.e., operating, capital) involved for Burkhardt Farms (lessee), and give reasons for your classification. You should consider all four possible classification criteria and explicitly note your decision rule, your analysis and your conclusion Classification of lease for Burkhardt Farms, the lessee: (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 6/10 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? No 202,921 231,217 = 87.76% PV? =!231,217 (The asset s FMV) FV 50,000 N 6 I 8 PMT 40,000 PV? =!202,921 (PV of MLP) FV 20,000 N 6 I 10 PMT 40,000 For the lease to be classified as a capital lease for the lessee, at least one of the first four criteria must be met. If not, it is an operating lease. This lease qualifies as an operating lese for the lessee because none of the first four criteria is met. This is an operating lease to the lessee. 2. In case it is a capital lease for Burkhardt Farms (lessee), prepare an amortization table for Burkhardt Farms as a possible aid in the accounting for the lease. Please round all amounts to dollars. Date Bal @ BOY Cash Pmt Bal after Pmt Interest Bal @ EOY Date 1/1/2005 202,921 40,000 162,921 16,292 179,213 12/31/2005 1/1/2006 179,213 40,000 139,213 13,921 153,134 12/31/2006 1/1/2007 153,134 40,000 113,134 11,313 124,447 12/31/2007 1/1/2008 124,447 40,000 84,447 8,445 92,892 12/31/2008 307

1/1/2009 92,892 40,000 52,892 5,289 58,181 12/31/2009 1/1/2010 58,181 40,000 18,181 1,819 20,000 12/31/2010 3. Prepare all journal entries for 2005 and 2006 for Burkhardt Farms (lessee) to account for the lease. Be sure to date each entry. Please round all amounts to dollars (no cents). The preceding table is not needed because this is an operating lease. The entries are: 1/1/2005 Rent Expense 40,000 Cash 40,000 1/1/2006 Rent Expense 40,000 Cash 40,000 4. Show how this lease will be reported on Burkhardt s balance sheet, income statement and statement of cash flows for 2005, assuming a fiscal year equal to the calendar year. Ppd/ Total Current Long-term Operating Non-op Operating Investing Financing PPE Liability Liability Liability Income Income Activities Activities Activities 2005 0/0 0 0 0!40,000 0!40,000 0 0 2006 0/0 0 0 0!40,000 0!40,000 0 0 5. Identify the type of lease (i.e., operating, direct-financing, or sales-type) involved for Wynk Equipment (lessor), and give reasons for your classification. You should consider all seven possible classification criteria and explicitly note your decision rule, your analysis and your conclusion. If it isn t written down, I ll assume that you didn t consider it. (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 6/10 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 212,312 231,217 = 91.82 % PV? =!212,312 (PV of MLP) FV 20,000 N 6 I 8 PMT 40,000 (5) Collectibility of future payments is reasonably predictable? No (6) Are the amounts of future unreimbursable costs by the lessor known with reasonable 308

certainty? Yes (7) Does the lessor recognize a profit (fmv > book value) on the leased asset? Yes, fmv of 231,217 exceeds recorded cost of 150,000. For the lease to be classified as some sort of capital lease for the lessor, at least one of the first four criteria must be met, as well as both criteria 5 and 6. If not, it is an operating lease. This lease does not qualify as some sort of capital lease for the lessor because although one of the first four criteria is met (#4) as needed, criterion #5 is not met and criterion #6 is met. Although one of the first four is met and #6 is met, because #5 is not met it is an operating lease. This is an operating lease to the lessor. 6. Prepare all journal entries for 2005 and 2006 for Wynk Equipment (lessor) to account for the lease. Be sure to date each entry. Please round all amounts to dollars (no cents). If Wynk accounts for the lease as some sort of capital lease, prepare an amortization table to assist in the accounting. 1/1/2005 Asset on lease 150,000 Inventory 150,000 1/1/2005 Cash 40,000 Rent Revenue 40,000 12/31/2005 Depreciation Expense 16,667 Accumulated Depreciation 16,667 The amount of depreciation expense is certainly open to debate. It might be argued that with an expected useful life of 10 years it should be 150,000 10 = 15,000 per year. It might be argued that in attempting to match the cost of the asset to the dollars of benefit, more benefit is to be received in the next six year than in the years to follow. Therefore, (150,000! 50,000) 6 = 16,667 could be the amount. 1/1/2006 Cash 40,000 Rent Revenue 40,000 7. Repeat requirements 5 & 6, assuming that the collectibility of the lease payments is reasonably assured. (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 6/10 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 212,312 231,217 = 91.82 % PV? =!212,312 (PV of MLP) FV 20,000 309

N 6 I 8 PMT 40,000 (5) Collectibility of future payments is reasonably predictable? YES (6) Are the amounts of future unreimbursable costs by the lessor known with reasonable certainty? Yes (7) Does the lessor recognize a profit (fmv > book value) on the leased asset? Yes, fmv of 231,217 exceeds recorded cost of 150,000. For the lease to be classified as some sort of capital lease for the lessor, at least one of the first four criteria must be met, as well as both criteria 5 and 6. If not, it is an operating lease. This lease qualifies as some sort of capital lease for the lessor because one of the first four criteria is met (#4) as needed, and criteria #5 and #6 are met, also as needed. Because there is a dealer profit of 81,217, this is a sales type lease to the lessor. Date Bal @ BOY Cash Pmt Bal after Pmt Interest Bal @ EOY Date 1/1/2005 231,217 40,000 191,217 15,297 206,514 12/31/2005 1/1/2006 206,514 40,000 166,514 13,321 179,835 12/31/2006 1/1/2007 179,835 40,000 139,835 11,187 151,022 12/31/2007 1/1/2008 151,022 40,000 111,022 8,882 119,904 12/31/2008 1/1/2009 119,904 40,000 79,904 6,392 86,296 12/31/2009 1/1/2010 86,296 40,000 46,296 3,704 50,000 12/31/2010 1/1/2005 Lease Receivable 231,217 Cost of Goods Sold Expense 131,095 Inventory 150,000 Sales Revenue 212,312 (CGS & Revenue are reduced by the PV of 30,000 of URV) 1/1/2005 Cash 40,000 Lease Receivable 40,000 12/31/2005 Lease Receivable 15,297 Interest Revenue 15,297 1/1/2006 Cash 40,000 Lease Receivable 40,000 12/31/2006 Lease Receivable 13,321 Interest Revenue 13,321 310

Solution to Problem 12 Unguaranteed residual value; implicit rate in lease 1. Calculate the annual lease payments required by SSI. PV!48,000,000 FV 25,000,000 N 10 I 12 PMT? = 6,313,068 2. What type of lease is the above to SSI? To KIC? Explain and show calculations. Classification of lease for SSI, the lessor: (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 35/100 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? No 39,950,671 48,000,000 = 83.23% PV? =!39,950,671 FV 0 N 10 I 12 PMT 6,313,068 (5) Collectibility of future payments is reasonably predictable? Yes (6) Are the amounts of future unreimbursable costs by the lessor known with reasonable certainty? Yes (7) Does the lessor recognize a profit (fmv > book value) on the leased asset? No, fmv of 48,000,000 equals recorded cost of 48,000,000. For the lease to be classified as some sort of capital lease for the lessor, at least one of the first four criteria must be met, as well as both criteria 5 and 6. If not, it is an operating lease. This lease does not qualify as some sort of capital lease for the lessor because none of the first four criteria is met. This is an operating lease to the lessor. Classification of lease for FFF, the lessee: (1) Transfer of ownership? No 311

(2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 35/100 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 45,750,096 48,000,000 = 95.31% PV? =!45,750,096 FV 0 N 10 I 8 PMT 6,313,068 For the lease to be classified as a capital lease for the lessee, at least one of the first four criteria must be met. If not, it is an operating lease. This lease qualifies as a capital lease for the lessee because one of the first four (#4) criteria is met. This is a capital lease to the lessee. 3. Prepare all necessary entries for SSI and for KIC (a) at the inception of the lease and (b) for the first two years of the lease. KIC made five shuttle flights during the first year and three flights during the second year. Both parties base depreciation on usage. If either company accounts for the lease as some sort of capital lease, prepare the necessary amortization table. Journal entries for SSI (Lessor). Since it is an operating lease, no amortization table is necessary. Beg 1 st yr Cash 6,313,068 Rent Revenue 6,313,068 End 1 st yr Depreciation Expense 2,400,000 Accumulated Depreciation 2,400,000 (only 5 of its expected 100 flight usage: 48 mill 100 Beg 2 nd yr Cash 6,313,068 Rent Revenue 6,313,068 End 2 nd yr Depreciation Expense 1,440,000 Accumulated Depreciation 1,440,000 Journal entries for FFF (Lessee). Since it is capital lease, an amortization table is necessary. Date Bal @ BOY Cash Pmt Bal after Pmt Interest Bal @ EOY Date 1/1/1 45,750,096 6,313,068 39,437,028 3,154,962 42,591,990 12/31/1 1/1/2 42,591,990 6,313,068 36,278,922 2,902,314 39,181,236 12/31/2 1/1/3 39,181,236 6,313,068 32,868,168 2,629,453 35,497,621 12/31/3 1/1/4 35,497,621 6,313,068 29,184,553 2,334,764 31,519,317 12/31/4 1/1/5 31,519,317 6,313,068 25,206,249 2,016,500 27,222,749 12/31/5 1/1/6 27,222,749 6,313,068 20,909,681 1,672,774 22,582,455 12/31/6 312

1/1/7 22,582,455 6,313,068 16,269,387 1,301,551 17,570,938 12/31/7 1/1/8 17,570,938 6,313,068 11,257,870 900,630 12,158,500 12/31/8 1/1/9 12,158,500 6,313,068 5,845,432 467,636 6,313,068 12/31/9 1/1/10 6,313,068 6,313,068 0 0 0 12/31/10 1/1/01 Leased Asset 45,750,096 Lease Payable 45,750,096 1/1/01 Lease Payable 6,313,068 Cash 6,313,068 12/31/01 Interest Expense 3,154,962 Lease Payable 3,154,962 12/31/01 Depreciation Expense 6,535,728 Accumulated Depreciation 6,535,728 (Only 5 of its 35 flights) 1/1/99 Lease Payable 6,313,068 Cash 6,313,068 12/31/01 Interest Expense 2,902,314 Lease Payable 2,902,314 12/31/01 Depreciation Expense 3,921,437 Accumulated Depreciation 3,921,437 Lessee s financial statement disclosures Date PPE CL LtLiab Op Inc Non-op Inc OA IA FA 12/31/01 39,214,368 6,313,068 36,278,922 (6,535,728) (3,154,962) 0 0 (6,313,068) 12/31/02 35,292,931 6,313,068 32,868,168 (3,921,437) (2,902,314) (3,154,962) 0 (3,158,106) 313

Solution to Problem 13 Guaranteed residual value 1. Determine how AC (the lessor) and FFF (the lessee) should classify the lease. Classification of lease for AC, the lessor: (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 4/6 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 3,500,000 3,500,000 = 100% PV? = 3,500,000 FV 600,000 N 8 I 6 PMT 474,532 (5) Collectibility of future payments is reasonably predictable? Yes (6) Are the amounts of future unreimbursable costs by the lessor known with reasonable certainty? Yes (7) Does the lessor recognize a profit (fmv > book value) on the leased asset? Yes, fmv of 3,500,000 exceeds recorded manufacturing cost of 3,000,000. For the lease to be classified as some sort of capital lease for the lessor, at least one of the first four criteria must be met, as well as both criteria 5 and 6. If not, it is an operating lease. This lease qualifies as some sort of capital lease for the lessor because one of the first four (#4) criteria is met, as well as both criteria 5 and 6. Criterion 7 establishes whether it is a direct financing type lease (with no profit) and a sales type lease (with profit). Because there is profit of $500,000, this is a sales type lease to the lessor. Classification of lease for FFF, the lessee: (1) Transfer of ownership? No (2) Bargain purchase option? No (3) Length of lease term $ 75% of asset s total expected life? No, 4/6 < 3/4 (4) Present value of minimum lease payments $90% of asset s current FMV? Yes 3,500,000 3,500,000 = 100% PV? = 3,500,000 314

FV 600,000 N 8 I 6 PMT 474,532 For the lease to be classified as a capital lease for the lessee, at least one of the first four criteria must be met. If not, it is an operating lease. This lease qualifies as a capital lease for the lessee because one of the first four (#4) criteria is met. This is a capital lease to the lessee. 2/3 Journal entries for lessor and lessee The first step is to create an amortization table. It is a coincidence that the same table will work for both lessor and lessee. For this to happen, the rates have to be the same and and URV must be zero. Date Bal @ BOY Cash Pmt Bal after Pmt Interest Bal @ EOY Date 7/1/98 3,500,000 474,532 3,025,468 181,528 3,206,996 1/1/99 1/1/99 3,206,996 474,532 2,732,464 163,948 2,896,412 7/1/99 7/1/99 2,896,412 474,532 2,421,880 145,313 2,567,193 1/1/00 1/1/00 2,567,193 474,532 2,092,661 125,560 2,218,220 7/1/00 7/1/00 2,218,220 474,532 1,743,688 104,621 1,848,310 1/1/01 1/1/01 1,848,310 474,532 1,373,778 82,427 1,456,204 7/1/01 7/1/01 1,456,204 474,532 981,672 58,900 1,040,573 1/1/02 1/1/02 1,040,573 474,532 566,041 33,959 600,000 7/1/02 For Lessor s accounting for a sales type lease, Cost of Goods Sold and Sales revenue are reduced by the PV of URV. Since URV = 0, there is no reduction. Lessor s journal entries: 7/1/98 Lease Receivable 3,500,000 Cost of Goods Sold Expense 3,000,000 Inventory 3,000,000 Sales Revenue 3,500,000 7/1/98 Cash 474,532 Lease Receivable 474,532 12/31/98 Lease Receivable 181,528 Interest Revenue 181,528 1/1/99 Cash 474,532 Lease Receivable 474,532 6/30/99 Lease Receivable 163,948 Interest Revenue 163,948 7/1/99 Cash 474,532 Lease Receivable 474,532 12/31/99 Lease Receivable 145,313 Interest Revenue 134,313 315

Lessee s journal entries: 7/1/98 Leased Asset 3,500,000 Lease Payable 3,500,000 7/1/98 Lease Payable 474,532 Cash 474,532 12/31/98 Interest Expense 181,528 Lease Payable 181,528 12/31/98 Depreciation Expense 362,500 Accumulated Depreciation 362,500 1/1/99 Lease Payable 474,532 Cash 474,532 6/30/99 Interest Expense 163,948 Lease Payable 163,948 7/1/99 Lease Payable 474,532 Cash 474,532 12/31/99 Interest Expense 145,313 Lease Payable 134,313 12/31/99 Depreciation Expense 725,000 Accumulated Depreciation 725,000 316

Solution to Problem 14 Lease accounting for lessor. (1) Prepare a lease amortization table to assist Taves (LESSOR) in the accounting for this lease. Please round all amounts to dollars. Your table should contain an adjustment to account for rounding errors. BOY Bal Date BOY Bal Pmt after pmt Interest EOY Bal Date June 1, 2009 675,000 128,873 546,127 44,782 590,909 June 1, 2010 June 1, 2010 590,909 128,873 462,036 37,887 499,923 June 1, 2011 June 1, 2011 499,923 128,873 371,050 30,426 401,476 June 1, 2012 June 1, 2012 401,476 128,873 272,603 22,353 294,956 June 1, 2013 June 1, 2013 294,956 128,873 166,083 13,619 179,702 June 1, 2014 June 1, 2014 179,702 128,873 50,829 4,171 55,000 June 1, 2015 (2) Prepare all journal entries that Taves (LESSOR) will need for 2009 and 2010. 4/1/09 Leased Assets 640,000 Cash 640,000 6/1/09 Lease Receivable 675,000 Cash 5,000 Leased Assets 640,000 Gain 30,000 6/1/09 Cash 128,873 Lease Receivable 128,873 12/31/09 Lease Receivable 26,123 Interest Revenue 26,123 44,782*7/12 6/1/10 Lease Receivable 18.659 Interest Revenue 18,659 44,782*5/12 6/1/10 Cash 128,873 Lease Receivable 128,873 12/31/10 Lease Receivable 22,101 Interest Revenue 22,101 317